The lost art of raising prices

For many years, as inflation was low, corporate gains in efficiency, cost cutting and outsourcing exercises made it possible to maintain or increase dollar-for-dollar profitability. Unfortunately, under current economic conditions, this is no longer possible. Amidst a rise in inflation, the cost of raw materials, and the cost of transport and energy, companies face, for the first time in many years, the dread of increasing their prices.

• Sales people dread price increases because they forgot how to defend them a long time ago. And as their customers are no longer accustomed to “the annual price increase”, sales people believe they will face strong resistance.
• Executives dread the price increases because they think their competitiveness will suffer.

But there are several positive aspects of price increases.

Share price:
For example, yesterday, Chemtura Corp., a global producer of specialty chemicals and polymer products announced a price increase of approximately 15%. The result – shares immediately gained 2.8%, and have continued to raise today.

You deliver results:
Furthermore, your customers are doing business with you because you deliver results. Your product or service provides value to your customers, and the vast majority of your customers want to continue to do business with you. They want you to take care of your business so they can continue to gain value from what you deliver to them.

Stronger customer relationships:
Announcing a price increase also gives you the opportunity to remind your customers about the value you provide, and have provided for a long time. And, by telling customers all the things you’ve done to avoid price increases until now, your relationship can grow stronger. But this is a message your salespeople are not used to delivering, and they will need the right ammunition and training to do so effectively and successfully.

Revisit your pricing strategy:
As you revise your pricelist, it is also a good idea to look for methods through which you can tweak your prices in such a way as to drive customers to buy more profitable products or services from you -- ways in which you can change the product mix you are selling to become more profitable overall.

So there are several aspects to a price increase – and when it comes down to it, they are mostly positive. But a successful price increase needs to be carefully planned; salespeople need the appropriate training and you need to ensure you plan thoroughly to convert the looming price increase into a positive opportunity for your company to gain further profitability.

With warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com

Update on Dell and Apple - Drop your margin 3% and lose $14b!

I thought it is appropriate with a update on my Dell and Apple story from July 22. See below.

Dell on Thursday reported a fiscal second-quarter profit of $616 million, or 31 cents a share, on $16.43 billion in revenue. During the same period a year ago, Dell earned 33 cents a share on revenue of $14.77 billion. The result was an immediate -1.8% drop in share price.

Per Sjofors

The AppStore, a microcosmos for understanding price elasticity

On a number of technology blogs, a bit of grumbling has started over the price of software bought from Apple’s AppStore. So let me just explain what this is.

I’m sure you are aware of the iPhone, one of the hottest consumer electronics products in the last 12 months. About a month and a half ago, Apple introduced an updated version of the product, the iPhone 3G. As the phone is basically a small portable computer, Apple also introduced what they call the AppStore, a section of iTunes where iPhone users can download small software applications. The AppStore has been a huge success, with hundreds of these iPhone applications available, selling more then $30m worth of software in the first month despite the fact that a majority of the apps are available for free.

Each developer set his or her own application price, or decides to give the app away for free, though most chargeable apps sell for $2.99 – $9.99. And on various technology blogs, I'm starting to hear about one of the world’s most common pricing mistakes. Developers are complaining, to whomever wants to listen, saying things like “I used my gut feel to price my app at $9.99 and it did not sell very well, so I dropped the price to $2.99 and sure I’m selling more but I’m getting less revenue”. This is a classic example of the perils of price elasticity. Price elasticity is a fancy name for how the demand of a product or service changes with the price. If the demand changes little with the price, then the price elasticity is low (or inelastic); if it changes a lot, price elasticity is high (elastic).

Once the elasticity curve is known, it is easy to generate a revenue curve. The revenue curve points out the best or optimum price, where the combination of price and demand generates the maximum revenue. If your market is elastic, and most markets are, selling your product at the optimum price point is crucial for the business results of your company, and can easily mean the difference between market leadership and marginalization.

These AppStore developers have a very unique advantage in the way they can discover the price elasticity curve for their product by simple trial and error. An advantage virtually no other company has. They sell software, so revenue max is also profitability max, they promote their product to a “closed” marketplace as they only compete with other software companies in the AppStore, and they can change the price as often as they wish.

So an AppStore developer can start with a price of, say, $9.99, wait a month, note the demand, change the price to $6,99, wait a month, note the demand, change the price to $4.99, wait a month note the demand and so forth. After plotting 5 to 6 demand points, all with prices taken out of thin air, it will be easy to set the optimum price, the price that will give the developer maximum revenue and profits. Of course, during this process, the company is losing revenue; leaving money on the table to define the lower-than-optimum demand points and forsaking sales volume to define the higher-than-optimum demand points.

Any company can do the same. Whether you are selling farm equipment, data storage, shovels, or boxed software the process is identical, but, because you don’t have the advantages of easily changing your prices on a platform like the AppStore, the process will be longer – probably a few years. And chances are that by the time you are done, your marketplace will have changed so much it will be time to start the process all over again. Not to mention that in the process, you will give up millions in lost revenues and margin.

So when you priced your product, did you use some combination of “gut feel”, “I know exactly what the market will bear”, or the all-too-frequent “our cost plus x % markup”? If you did, what are the chances that by sheer luck you will hit the optimum price point? If you were one of the very few who found that price point by luck, you probably have revenues beyond your wildest dreams. But if not, chances are much higher you are struggling to meet the numbers. If your company is like 99% of companies out there, you can easily gain 10% – 20% in revenue, double your growth rate, and double profitability by knowing the price elasticity of your product, and optimizing your price accordingly. Think about it. What would price optimization mean for your company?

And if experimenting with different price levels and seeing how they affect demand is not a realistic possibility at your company, as the cost in lost business is too high, how will you be able to define the optimum price?

With warm summer regards,

Per Sjofors
Founder & Managing Partner
Atenga Inc
www.atenga.com